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The New Face of Reverse Mortgages

Reverse mortgages used to be the last recourse of the little old lady: A way for her to get money for household help and stay in her home until she died.

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But now, baby boomers are sniffing around these backwards loans, looking for a way to pay off other debts and provide bridge funding for the early years of retirement. In a reverse mortgage, a lender pays money to a homeowner, but the homeowner has no monthly payments. The loan, plus interest, is repaid when the home is sold.

Almost half of the people now considering a reverse mortgage are under the age of 70, and 21% are ages 62 to 64, according to a new study by the MetLife Mature Market Institute and the National Council on Aging. The average age of borrowers is 73; in 1990 it was 76, according to the Department of Housing and Urban Development.

MetLife hypothesizes that the increased demand from younger borrowers is a result of the punishing economy: Reverse mortgages don't require borrowers to have income or healthy credit scores because they don't make payments. But there's something else in play, too. As the Federal Housing Authority has issued more consumer-friendly standards and lower cost options for reverse mortgages, they are having some appeal to a broader demographic.

Americans 62 and older (that's the minimum age for qualifying for a reverse mortgage) have $3.19 trillion in home equity, according to the National Reverse Mortgage Lenders Association.

Surely among them are some young retirees who may want to stay in their homes for a few years, but not forever. By using a reverse mortgage for those few years, they can wipe out their existing regular mortgage, make home repairs, defer starting their Social Security benefits and more. Those are the kinds of strategies that experts see coming to the fore.

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"In the future it is likely that tapping home equity will be viewed as part of the entire retirement planning process," said Barbara Stucki, vice president for home equity initiatives for NCOA. "It is likely the reverse mortgage option will be considered alongside some of the more traditional methods of saving and investment."

So, it's a strategy, but is it a smart one? Here are some considerations.

-- It can fill gaps. Ken Weingarten, a financial adviser from Lawrenceville, New Jersey, had one couple in their mid-60s take out a reverse mortgage so the 67-year-old husband could defer his Social Security benefit for three more years. He expects the couple, who had little savings, to pull no more than $60,000 out of their reverse mortgage. But that 3-year delay will increase the husband's permanent Social Security benefit by about 8% a year for each of the three years he defers, and that makes it worthwhile.

There's another way for a reverse mortgage to fill gaps. A couple who expects to downsize and live off the proceeds of their home sale in retirement can defer their move for a few years by pulling money from a reverse mortgage and paying it back when they sell the house.

-- It still isn't cheap. Even though FHA has created a lower cost reverse mortgage called a "saver" loan, closing costs can approach $20,000 or more on some reverse mortgages. And the interest rates run higher than they do for typical mortgages. Finally, because borrowers make no monthly payments, the balance on these loans actually grows as interest is assessed.

Here's an example from Norberto Maldonado, a Paramus, New Jersey, mortgage banker who acts as a broker for reverse loans: A couple of 66-year-olds with a $500,000 home and a $100,000 balance on a traditional mortgage could get $304,513 in a reverse mortgage. They would pay (after a rebate from his company) around $10,000 in closing costs. Their interest rate would be 5.06%, and after paying off their original loan and closing costs, they would receive $194,513. After one year, they would owe $321,000; after two years they would owe $341,000. After five years, they would owe $412,000, and after 10 years, $565,000. After 20 years? "They would owe about a million... it just keeps going up and up," he said.

-- These are no-recourse loans. That means that you won't owe the lender more than the sales price of the home, even if the loan eventually outstrips that. So if the couple above build a loan balance of $1 million and sell their house (at a fair market rate) for $700,000, it would be as if they got away with a free $300,000. That could theoretically offer a strategic opportunity for young borrowers, suggests David Hultstrom, a financial adviser from Woodstock, Georgia. But it would be risky.

-- You could keep it in the family. Joan Gagnon, a Mansfield, Massachusetts, financial adviser, once helped clients do an intrafamily reverse mortgage. The children, who (along with siblings) expect to inherit the home, loaned money to Mom so she could stay in it. Once she leaves and the home is sold, they will get their principal and interest back, first, and then the remaining value in the home would be divided among her heirs. If family members can afford this, it can be a much cheaper solution than a bank loan, says Gagnon. But siblings and parents should all agree, work with a lawyer to make sure the paperwork is done right, and know exactly what they are getting into.

-- Couples have to be careful. Sometimes a married couple will remove one partner from the home deed so the other can take out a reverse mortgage. That's not a good idea: If the borrowing spouse dies, the remaining spouse may be stuck with a balance due and no affordable way to repay it.

-- There goes the backup plan. Traditionally, reverse mortgages were viewed as last-ditch emergency funds. "People need to understand that if they tap their home equity at a young age, they may not have any left in 10 or 20 years, when they are facing a different kind of financial emergency," says Lori Trawinski, a reverse mortgage expert with AARP.

The Stern Advice column appears weekly, and at additional times as warranted. Linda Stern can be reached at linda.stern@thomsonreuters.com; She tweets at http://www.twitter.com/lindastern.; Read more of her work at http://blogs.reuters.com/linda-stern; Editing by Gunna Dickson